Hiring Family Members: Tax Benefits, Kiddie Tax Rules, and Family Partnership Planning

By Yarik Yarosh, CPA ·September 5, 2026 ·8 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

Hiring family members is one of the most effective legal income-shifting strategies available to small business owners. Under IRC 3121(b)(3)(A), wages paid by a sole proprietor (or a partnership where each partner is a parent) to a child under age 18 are exempt from FICA (Social Security and Medicare) taxes. If the child earns less than the standard deduction ($15,000 for 2025), they owe no federal income tax on the wages. The parent’s business deducts the wages as an ordinary business expense under IRC 162, shifting income from the parent’s top marginal rate to the child’s zero rate. A parent in the 37% bracket who pays a child $15,000 in legitimate wages saves $5,550 in income tax plus $2,295 in self-employment tax (employer share), for a total of $7,845 per child per year, with the child paying $0 in tax. Multiply that by multiple children and across multiple years, and the savings are substantial. However, the arrangement must be legitimate in every respect: the child must perform actual services, the wages must be reasonable for those services, and the business must maintain proper payroll records including timesheets, W-2s, and I-9 documentation.

✓Key takeaway

Family employment payroll tax exemptions:

Relationship	Employer Type	FICA Exempt?	FUTA Exempt?	Age Limit
Child	Sole proprietorship	Yes (under 18)	Yes (under 21)	Under 18 for FICA; under 21 for FUTA
Child	Partnership (only parents are partners)	Yes (under 18)	Yes (under 21)	Same
Child	S-Corp or C-Corp	No	No	N/A (payroll taxes always apply through a corporation)
Child	LLC taxed as sole prop/partnership (parents only)	Yes (under 18)	Yes (under 21)	Same
Spouse	Sole proprietorship	Yes for FUTA	No (FICA applies)	N/A
Parent	Sole proprietorship (child is employer)	No FICA	Yes for FUTA	N/A

Income shifting savings per child (2025):

Income Level	Tax Rate Saved	Per-Child Savings (at $15,000 wages)
37% bracket	37% + SE tax	~$7,845/year
35% bracket	35% + SE tax	~$7,545/year
32% bracket	32% + SE tax	~$7,095/year
24% bracket	24% + SE tax	~$5,895/year

How do you properly hire family members?

Hypothetical example

Round numbers. For current guidance, see IRS Employer Tax Guide. A sole proprietor with $300,000 in Schedule C income hires their three children (ages 10, 14, and 17) to work in the business.

Legitimate jobs for children:

Age	Job	Wage Range
10	Filing, organizing, cleaning the office, shredding documents	$8-12/hour
14	Data entry, inventory management, social media assistance, answering phones	$10-15/hour
17	Customer service, bookkeeping assistance, website updates, marketing tasks	$12-20/hour

Wage structure (reasonable for services):

Child	Hourly Rate	Hours/Week	Weeks/Year	Annual Wages
Age 10	$10/hour	5	40	$2,000
Age 14	$14/hour	10	40	$5,600
Age 17	$18/hour	15	50	$13,500
Total family wages				$21,100

Tax savings:

Item	Without Hiring Children	With Hiring Children
Parent’s taxable income	$300,000	$278,900
Parent’s income tax saved (35% bracket)	$0	$7,385
Self-employment tax saved (15.3%)	$0	$3,228
Children’s income tax	N/A	$0 (all below standard deduction)
Children’s FICA	N/A	$0 (sole prop, under 18 exemption)
Total annual tax savings		$10,613
Over 8 years (3 children working)		~$85,000

Roth IRA opportunity: Each child with earned income can contribute to a Roth IRA up to their earned income (max $7,000 for 2025).

Child	Earned Income	Roth IRA Contribution	Value at Age 65 (7% return)
Age 10	$2,000	$2,000	~$80,000 (55 years of growth)
Age 14	$5,600	$5,600	~$160,000 (51 years of growth)
Age 17	$7,000 (max)	$7,000	~$160,000 (48 years of growth)
Total		$14,600	~$400,000

These Roth IRA contributions grow tax-free, and the child pays no tax going in (earned income below the standard deduction). This is the most tax-efficient way to fund a child’s long-term wealth.

Documentation requirements (IRS will scrutinize):

Requirement	How to Comply
Real work performed	Job description for each child; work must be actual business tasks
Reasonable wages	Pay comparable to what you would pay an unrelated employee for the same work
Timesheets	Written record of hours worked, tasks performed
W-2 filed	Issue W-2 to each child by January 31
Payroll records	Maintain employment records as for any employee
Separate bank account for child	Wages deposited into the child’s own account
I-9 on file	Age-appropriate documentation
State labor law compliance	Check minimum age and hour restrictions in your state

Common mistakes that get arrangements disallowed:

Mistake	Why It Fails
No actual work performed	IRS treats wages as a gift, disallows deduction
Wages far exceed what unrelated employee would earn	Unreasonable compensation; excess disallowed
No timesheets or work records	Cannot prove the child actually worked
Paying a 5-year-old $15,000/year	Not credible; very young children cannot perform meaningful work
Not issuing W-2	Payroll non-compliance
Wages deposited into parent’s account	Looks like the parent kept the money (not genuine employment)
S-Corp or C-Corp employer	FICA exemption does not apply through corporate entities

Kiddie tax rules (IRC 1(g)): The kiddie tax applies to unearned income (investment income, interest, dividends, capital gains) of children under 19 (or under 24 if full-time students). It does NOT apply to earned income (wages).

Kiddie Tax (2025)	Rule
Applies to	Unearned income of children under 19 (under 24 if student)
First $1,350	Tax-free
Next $1,350	Child’s rate (10%)
Over $2,700	Parent’s marginal rate
Does NOT apply to	Earned income (wages, self-employment)

So wages paid to the child for actual work are never subject to the kiddie tax. But if the child takes their wages and invests them, the investment income above $2,700 would be taxed at the parent’s rate.

Employing a spouse:

Strategy	Benefit
Spouse as employee	Access to employer-provided benefits: health insurance, retirement plans, dependent care
Section 105 HRA	If the spouse is the only employee, employer can reimburse 100% of family medical expenses tax-free through a Section 105 plan
Retirement plan	Spouse as employee can participate in employer’s 401(k), SEP, or SIMPLE plan
FICA applies	Unlike children under 18, FICA applies to spouse’s wages
FUTA exempt	Spouse’s wages are exempt from FUTA (IRC 3306(c)(5))

Family limited partnership (FLP) for income shifting:

Feature	Details
Structure	Parents are general partners (1-2%); children are limited partners (98-99%)
Income shifting	Partnership income allocated to children per their partnership interest
Valuation discounts	Limited partnership interests valued at a discount (15-35% DLOM) for gift/estate tax
Kiddie tax risk	Partnership income allocated to children under 19/24 may be taxed at parent’s rate (it is unearned income for kiddie tax purposes)
IRC 704(e) family partnership rules	A child must be a bona fide partner; capital must be a material income-producing factor; allocation to child cannot exceed reasonable compensation for parent’s services
Best for	Families with significant investment or rental income; estate planning

Illustrative numbers only, not a real client and not advice for your facts.

Related guides:

What payroll tax deposits are required and when are they due?

Federal payroll tax deposits include withheld income tax plus both the employee and employer shares of FICA (Social Security and Medicare), and the deposit schedule depends on your total tax liability. Monthly depositors must deposit employment taxes by the 15th of the following month, while semi-weekly depositors must deposit by Wednesday for Saturday-Tuesday paydays and by Friday for Wednesday-Friday paydays. The IRS assigns your deposit schedule based on your lookback period liability (the four quarters ending June 30 of the prior year): $50,000 or less means monthly, over $50,000 means semi-weekly. The $100,000 next-day deposit rule applies regardless of your regular schedule. If you accumulate $100,000 or more in employment taxes on any day, you must deposit by the next business day and switch to semi-weekly status for the remainder of the year and the following year.

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Cite this page

Yarik Yarosh, CPA. "Hiring Family Members: Tax Benefits, Kiddie Tax Rules, and Family Partnership Planning." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-hiring-family-members-tax-benefits-kiddie-tax

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.